Loss of Blue Cross Contract is Big Loss for Medco, Win for CVS

By Avi Salzman

Pharmacy benefit manager Medco Health Solutions (MHS) is falling hard this morning after it failed to renew a big contract to provide pharmacy benefits to federal employees. The Blue Cross Blue Shield Association instead chose CVS Caremark (CVS) for the three-year contract, which MHS said was worth $3 billion. MHS says it handled 9.8 million mail-in prescriptions for Blue Cross through the contract, as well as some specialty pharmacy benefits. Medco dropped 11% to $57.54, while CVS was up 2.9% to $39.24.

Medco’s earnings won’t be affected until 2012, the company said, but the market is obviously anticipating a severe dropoff. Lazard Capital Markets analyst Tom Gallucci estimates the contract is worth about 35 cents of EPS — the company said it represents less than 10% of estimated 2011 EPS, which is expected to come in at $4.02 to $4.12. CVS already handles retail pharmacy benefits for the association, so combining the services under one roof could be saving the government money, Gallucci notes.

Prescription-by-mail is a high fixed cost business, Gallucci notes, and the loss of a big contract like this could sting.

“On one hand, we estimate that as a very large customer whose contract was competitively bid in the past the business generates well below average mail profitability,” he wrote. “On the other hand, we recognize the mail business is high fixed cost in nature, and losing almost 10% of related volume carries a negative leverage effect. We view the negative leverage as being more on the high fixed cost infrastructure as opposed to the loss having a material impact on MHS purchasing power.”

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